Bolívar Distorted: The Effects of Exchange Controls on the ...

Much <strong>of</strong> the exchange rate literature written before 2001 tends to support currency boards
and exchange rate pegs as a feasible and possibly effective way <strong>of</strong> reducing inflation and
creating confidence in a failing currency. <strong>The</strong> primary example <strong>of</strong> this is Estonia, a Baltic
country that instituted a currency board in the face <strong>of</strong> hyperinflation and the lack <strong>of</strong> confidence in
a new state’s currency following the fall <strong>of</strong> the Soviet Union. <strong>The</strong> board created stability and in
the new currency where there was formerly only chaos and allowed Estonia to make a smooth
transition from Soviet rule to independent capitalism. 14 Under the currency board arrangement,
Estonia reigned in hyperinflation over the course <strong>of</strong> a few years by reducing the money stock,
but also suffered from early negative GDP growth and cuts in social spending. 15 Estonia’s
currency board arrangement, combined with fiscal restraint and strong institutional reform,
showed that the type <strong>of</strong> exchange rate regime is not necessarily critical to the economic system,
but rather the institutional arrangement and management that surround it.
However, literature published after 2001 tends to discount more and more the idea <strong>of</strong> a
successful currency board being uniformly successful. It claims that currency boards require a
number <strong>of</strong> other factors in order to be successful, and show that a currency board is not a cure-all
for inflation and instability as some economists claim. 16 This change in thought follows the
collapse <strong>of</strong> the Argentinean economy. Under the enormous duress <strong>of</strong> a mounting external debt
and propping up a failing currency, the government was forced to abandon convertibility (the
ability to change pesos into dollars at a fixed rate) when there were no longer enough dollars to
back the domestic money supply. When the Central Bank ran out <strong>of</strong> dollars and the currency
board collapsed, it propagated a national economic crisis, replete with bank run and general
havoc. <strong>The</strong> literature cautions that while there have been failures in certain currency boards, the
14 Jakob de Haan, et.al. “How to reduce inflation?” 2001.
15 Dennis R. Appleyard and Alfred J Field, Jr. International Economics. 2001.
16 Graham Bird. “Cry for Argentina…not for its currency board.” New Economy. 2002.
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